SEC To Implement New Rules

January 21, 2008
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GRAND RAPIDS — The Securities and Exchange Commission raised its threshold for “smaller reporting companies” to those with a market capitalization of less than $75 million, up from the previous market cap of $25 million. Effective Feb. 4, those companies are eligible to use scaled-back SEC disclosure requirements that will reduce their disclosure burdens. 

For most companies that operate on the calendar year, the rules will apply to their 2008 annual report, according to Jeffrey Ott, a partner and securities attorney at Warner Norcross & Judd. The new rules also make it easier for a smaller business to raise capital through private offerings because the holding period for restricted securities was shortened from one year to six months in an effort to make capital cheaper and more accessible.

“In terms of public companies, where you’re likely to see this have the most impact is in the community banking area, in particular,” Ott said. “There are a number of publicly traded community banks that have market caps greater than $25 million but less than $75 million, so they’ll be able to cut back on their disclosure requirements in their SEC filings.”

Under the new rules, which the SEC says will affect 1,500 companies, smaller companies will also be permitted to choose which scaled-back disclosure requirements they prefer to take advantage of. Companies can choose to do the full-blown, “big-company” disclosures for some items and scaled-back disclosures for other items, Ott explained. Some refer to it as an “a la carte basis for disclosure.”

The pick-and-choose disclosure method will be most advantageous to a small business in terms of financial statements and executive compensation, Ott said. Smaller reporting companies only have to provide two years of balance sheet, income and cash flow statements, whereas larger companies have to provide two years of balance sheet statements but three years of income and cash flow statements. Where that flows through, he said, is in the management discussion and analysis section of their SEC filing, where they have to describe and compare the financial results of this year versus last year and the results of last year versus the year before. Since essentially a whole year of financial disclosure is cut out of the picture, it reduces disclosure burdens.

Where it’s really significant is in the executive compensation area, Ott said. The SEC revamped and expanded executive compensation disclosure requirements last year. One was the new “compensation discussion and analysis” requirement where the company basically has to provide a management discussion and analysis of its compensation practices. Under the new rules, the compensation discussion and analysis requirement doesn’t apply to smaller reporting companies, he said, so their burden is lightened in that respect.

The revamped executive compensation rules also required public companies to provide disclosure on their CEO, CFO, and the next three most highly compensated officers of the company, but under the new rules that become effective Feb. 4, smaller companies only have to provide information on the CEO and the next two most highly compensated officers. In addition, larger companies have to provide compensation information for the last three years, but under the new rules, smaller companies only have to go back two years.

But the “auditor attestation” debate continues over whether smaller public companies should be exempt from Section 404 compliance, which is considered one of the most onerous provisions of the Sarbanes-Oxley Act of 2002. The provision mandates that public companies evaluate and annually report on the effectiveness of their internal controls over financial reporting and that an independent auditor certify the controls. Many smaller publicly traded companies have complained of the time-consuming nature and high cost of compliance with this requirement. The SEC has repeatedly delayed imposing the rule on smaller companies and has been working with the Public Accounting Oversight Board and the industry in general to try to reach some agreement.

James Saalfield, chief administrative officer of Meritage Hospitality Group, said he thinks the SEC did the right thing by dialing back on what type of regulations were going to be put in place for the smaller companies. Meritage delisted from the American Stock Exchange more than a year ago to avoid the public company costs that ramped up after SOX went into effect. Its stock now trades on the OTCQ X.

Saalfield thinks the SEC finally realized that compliance is a much larger strain on smaller companies. Nevertheless, he still believes that many of Sarbanes Oxley elements that were put in place were largely overkill and a political response to what was headline news about Enron, MCI, WorldCom and others.

Had the new set of rules been in place two years ago, would it had made a difference in Meritage’s decision to delist or not to delist? Probably not, Saalfield said.

“It would have been helpful, but it wouldn’t have necessarily changed our decision. It was a very uncertain time, and we had to make our best guess on where things were ultimately going,” Saalfield. “The listing that we now have with the OTCQ X is a premium listing. If you look at what they require in terms of disclosure, it’s very similar to the way the SEC was 10 years ago. I think the OTCQ X has taken a much better approach. I know they’re getting new members all the time because of all of this.”

The new rules call for smaller reporting companies to begin auditor attestations for fiscal years ending after Dec. 15, 2008. However, SEC Chairman Christopher Cox has indicated that smaller reporting companies may get a one-year reprieve.

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